Bitcoin is stored in a bitcoin wallet. I have found that there are a lot of misconceptions around how a wallet works. A wallet doesn’t physically store bitcoin, it only holds the public and private keys for an individual to access their bitcoin.
As mentioned earlier, the blockchain is just a ledger of bitcoin balances. The public key for your wallet is the public address in the bitcoin ledger. So if you or someone else looks up your public key (for example on blockchain.info) they can see exactly how much bitcoin is stored in that wallet address.
However in order to access the bitcoin and spend it, the person must also have the private key. This private key is created when the wallet address is initially made. Usually a user creates a strong passphrase of at least 8 words and special characters; the larger the passphrase the harder it is to crack. So if I want to send my bitcoin from my address to my friends address, they will give me their wallet public address. I will then login to my wallet software as I control the private key to my account (via use of my passphrase) and use the ‘send’ function to send as an example 2.5 BTC. I will send it to my friends wallets public address.
Once this occurs, the bitcoin network receives the request and it is processed into the first available block. Essentially all that is occurring is the network will remove 2.5BTC from my address on the bitcoin ledger and add 2.5BTC to my friends address on the bitcoin ledger. Miners confirm this transaction and as a reward for this, they receive a small amount of BTC as a transaction fee to incentivise their participation.
Online, offline, cold, hot… wallets?
Here is a quick breakdown of the different types of cryptocurrency wallets:
Online wallet: A web-based wallet. Data is hosted on an online server and controlled by a third party. Generally the data is heavily encrypted to ensure it is safe. Still, it is probably the least safest form of wallet.
Software wallet: The most common type of wallet, this includes desktop and mobile wallets. This is usually an app that connects directly to the coin’s server/interface.
Paper wallet: This is a physical document that contains copies of the public and private keys that make up a wallet. Often it will have QR codes (add to glossary), so that you can quickly scan them and add the keys into a software wallet to make a transaction. The benefit of a paper wallet is that the keys are not stored digitally anywhere, and are therefore not subject to cyber-attacks or hardware failures. The disadvantage of a paper wallet is that paper and ink can degrade, and paper is relatively fragile. If you lose a paper wallet (or can’t read what is on it), you’ll never be able to access the coins sent to its address.
Hardware wallet: Dedicated hardware built to hold cryptocurrency. This includes USB sticks, including encrypted ones built specifically for crypto such as Ledger Nano. These devices can go online to make transactions and get data and then can be taken offline for transportation and security. They are generally considered the safest form of wallet.
Personally, I wouldn’t bother with online wallets. I would also only use a software wallet if it was necessary for the coin I had chosen to purchase. If you wish to secure your wallet and/or have access to security and ease of use, a Ledger Nano may be your best bet. Otherwise a combination of a paper wallet plus a dedicated USB stick may be an option. Just ensure that you are very familiar with how this works before attempting it.
The reason a USB stick is safe for beginners is it can only ever be connected to the computer when the computer is in airplane/offline mode. This is ‘cold storage’ – it is not ultra secure, but for our purposes it is likely to be enough. To play with paper wallets and understand public and private keys, I would go to the bitcoin paper wallet site and play around. Make sure you also try to use the BIP38 encryption to see how to add a passphrase to your private key.
Then practice decrypting using the BIP38 passphrase also. When playing on this site, don’t worry you can’t cause any problem as you have no funds involved with the address your are generating.